The Minneapolis-St. Paul Business Journal held a panel discussion recently on the cannabis industry. Panelists included Carol Moss, attorney, Hellmuth & Johnson; Nikki Rohloff, CPA, founder and CEO, Rohloff Associates and Canopy Accounting; Gerry Fornwald, shareholder, Winthrop & Weinstine; and Angela L’Esperance, founder, Ms. Jane Accounting. Megan Krohn, advertising director at the MSPBJ, served as moderator.
Megan Krohn: What is the state of recreational cannabis in the marketplace and what are you forecasting in the next couple years?
Nikki Rohloff: We’re waiting on licensing to go through. We had a lot of push when people were filing their applications for getting their SOPs and business plans in place or pro formas.
Gerry Fornwald: I think things are on track to see a functioning market sometime in 2025. It’s possible we could see licenses being issued this summer with product available later in the year. That’s a best-case scenario, but possible.
Krohn: Why has it taken so long?
Carol Moss: In Minnesota, unlike a lot of states that have gone recreational recently, we did not have a robust medical cannabis program. We actually had one of the most conservative in the country with only two licensed medical cannabis companies. They were completely vertically integrated meaning they were seed to shelf. Because that program was so conservative and so small, it didn’t have the infrastructure to support a whole industry. We had to start from nothing. The Office of Cannabis Management had to be created. They had to hire people, find desks, buy computers. We had to create the whole regulatory scheme, the whole statute, the whole rules and regulations, the whole application, everything. I also remind people, we are taking something that was illegal, people going to prison over it, and turning it to a multi-billion-dollar industry. This isn’t easy stuff.
Krohn: What are those things that are making it so challenging for somebody who’s interested in that entrepreneurial space to step into the cannabis business?
Moss: This is an extremely high-risk, high-reward industry. A lot of businesses fail; even more cannabis businesses fail. And there are so many pitfalls with such a highly regulated industry that can trip up even the most experienced entrepreneurs. When we have conflicts with federal law, that just really stacks the deck against people.
Angela L’Esperance: There’s a common misconception that a cannabis business can be ran similar to other businesses. This is inaccurate due to the complexity, the ever-changing Federal and State rules, and the limited deductions and credits. Additionally, not all banks, software platforms, payroll providers, web platforms, etc. support cannabis. This is an expensive space to operate in and raising capital for a cannabis business can be difficult. It is not necessarily the cash cow some make it out to be and not everyone is equipped to run a successful and sustainable cannabis business.
Fornwald: The other obstacle I would point out is capital raising. It is going to be far more difficult to go from license to operation in this industry than it is in other conventional markets, with one of the biggest struggles being a lack of traditional financing. Not being able to walk into a bank, present a business plan, and provide security in your inventory in exchange for a loan makes starting a business challenging. So people turn to private or nontraditional financing sources. There are also numerous potential pitfalls within the statute. If you receive a social equity license, you’re now limited in who you can get money from and in who you can sell a piece of your business to in order to keep your social equity status.
Moss: When we were creating the licensing structure, one of our goals was to have a Minnesota-centric craft industry, not an industry owned and operated by a few multi-state operators. We wanted to create small businesses for Minnesota, and so there are restrictions on the number and the types of licenses that you can hold at the same time, in order to prevent big companies from being able to come in and dominate the commerce stream.
Rohloff: A lot of clients who want to maintain a hemp business can’t have that same license if they want to pursue cannabis as well. You can run hemp under a cannabis license, but hemp is 100 percent tax deductible while cannabis is not. So we’ve been trying to work our way through that. How to best merge those two or figure out a way that works for both of them has been one of our bigger challenges.
Fornwald: Let’s say you’re an existing hemp edible manufacturer or owner, and you want to get an adult use cannabis license of some kind. From a licensing standpoint, you’re not able to be on both sides of the fence. From an operations standpoint, it’s possible to put them all under one umbrella, but you’re not going to be able to operate a low potency manufacturer and an adult use cannabis operation (under any license type) simultaneously. In order to do both, you either have to streamline the ownership structure so that all owners of the business own everything, or you’re going to have to house one of the businesses with somebody else.
Krohn: How are you advising people to navigate that? If they are wanting to transition, what are the options?
Fornwald: In a perfect world, we would have had months to prepare for this. But perhaps indicative of the industry, there was a lot of last-minute decision making. My advice to clients has been to pick which side you want to be on. First and foremost, if your ownership structure doesn’t allow for participation on both sides, you’ll have to decide which you’d like to pursue. You should not be a true party of interest so that you need to be disclosed on the license application of the other licensee, and you should make sure that you’re not doing anything to exercise control or take an interest in any profits or revenues. We’re seeing a lot of these applicants divided along family lines, with one family member running one side of the business (say, the low potency side), and a different family member running the cannabis side of the business.
Rohloff: That’s what we have been doing as well. A lot of our clients have sold their hemp business to a family member or another partner. But that does create a taxable event which people are very unaware of, and obviously some of these businesses are early stage. They don’t have a ton of income yet to be able to pay the tax and buy out their partner. For owners who are a little bit more risk tolerant, we are actually going to set up a way with their books to run both, since if you have a cannabis license that you can have the hemp-derived in there, and we’re taking a more aggressive approach, saying how much we’re going to carve out and say, this is hemp-derived, this is cannabis-derived. You’re basically exposing your hemp business now to the IRS as being 280E subjective, and so there has to be a risk tolerance there that people are willing to take. But right now, that is the literally the only option, unless you sell the hemp company in order to run your cannabis company.
Krohn: In terms of auditing and documentation, it sounds like you better have saved everything that you’ve ever written.
Rohloff: Every receipt possible.
L’Esperance: Agreed, having the proper documentation in order from day one to prepare for an audit is important. A cannabis business owner can prepare for audits by working with an experienced cannabis specialized accounting and tax team, maintaining accurate and current books and taxes, following a reputable Record Retention Guide, and keeping their records organized with proper backup and documentation. Essentially, you want to substantiate everything related to the business.
Moss: People have the misconception that the ease that it was to get into the hemp industry will translate to cannabis. But it’s a 180 degree difference. It is a complete opposite seed from shelf tracking. Every step is regulated. You watch every movement. It’s just a completely different animal. So it has been a very difficult transition for people who have been successful in hemp industry to transition into cannabis.
Krohn: Are there initiatives, plans to communicate more broadly the challenges we’re up against? What do you think is important for the larger business community to know about the challenges in this industry?
Moss: I would encourage them to look at the industry, work with people in the industry, and understand that these are businesses that you can enter into good business deals with. Also, to not to be scared to work with a cannabis business. We need professionals in this industry to support these businesses: accounting, attorneys, bankers, marketing gurus, etc. It’s a really exciting time to get involved.
Rohloff: The other big thing that people don’t realize is how tight-knit together this cannabis and hemp industry already is in Minnesota. A lot of the people already know each other. They’re willing to work with one another, and that’s something I haven’t seen across the other industries we work in, having such a tight-knit community that’s willing to help each other out and really bring it to the forefront, get rid of the stigma around cannabis. I’m excited to see how people continue to support each other.
Fornwald: There are more than 500 registrants within Minneapolis alone who are licensed or registered to sell low-potency products today. We’re talking about everything from co-ops to hair salons to coffee shops. Hemp beverages have become ubiquitous – they’re everywhere and the sky isn’t falling. So although it wasn’t planned, the unexpected benefit of the widespread, semi-unregulated early hemp edible market was that it allowed everyone to get comfortable with the fact that THC was being added to products and “reefer madness” hadn’t occurred. It’s allowed for the integration of hemp into other businesses and has reinforced that it’s here to stay.
Moss: Yes. A lot of people don’t understand that Minnesota started the THC beverage and low-dose edible industry that has taken off across the country. It has opened cannabis up people who would have never been opening to consuming cannabis, like my grandmother, who takes these 1-milligram melts. People consume these products as an alcohol replacement. We would not have legalization if it were not for women advocates who have been pushing for years. Nikki and I served together on the National Association of Women Business Owners. We have seen uniqueness in this industry, of women saying, OK, we don’t want to play catch up, we want a seat at the table from the very beginning.
Krohn: With various Office of Cannabis Management regulations, whether that’s importing or exporting across state lines, what do manufacturers, retailers need to know?
Fornwald: Is a law really a law if it is not enforced? That is what it comes down to. From a federal standpoint, a food or beverage that has a hemp-derived cannabinoid added to it is federally illegal. It’s a violation of federal laws - that product is adulterated food and it cannot cross state lines or be sold in interstate commerce. The reality is that some of the most abundant work our firm has been doing over the last several months is with manufacturers and distributors looking to enter into new markets outside of Minnesota, potentially through distribution agreements or direct sale agreements. Hemp-derived product is freely flowing across state lines. And at this point, the FDA has taken the position, it seems, that they’re not going to do anything about it as long as you’re not making outlandish claims about health effects or unsubstantiated cures, etc. It’s being treated as a state issue. The question then becomes, if you’re a Minnesota-based manufacturer and you want to sell product in Iowa, what do Iowa state laws say about hemp infused beverages and foods? That’s what we’ve been helping clients navigate.
Krohn: Angela or Nikki, anything to add on that from accounting perspective around interstate challenges?
Rohloff: Bigger thing is sales tax. You’re more likely to get audited with a sales tax audit of a state than you are by the IRS or Department of Revenue on income tax. It is definitely sales tax that states are going after, and the majority of states, it’s $100,000 or 200 transactions. People buy online, and it creates a whole back-end issue for the seller to get all that set up to make sure they’re collecting the right sales tax. And that’s been the bigger issue that we’ve seen on that side of it.
L’Esperance: I’d like to add that we can’t always depend on software to integrate with each other the way they are expected to. For sales tax in particular, MN has a unique market with the low dose and soon to be adult use market that software providers may not be set up properly for. We’ve witnessed business owners trying to automate sales tax through integrations, but that all needs to be verified and reconciled on a regular basis. Calculation errors on sales tax can be expensive and detrimental to a business, so it’s vital to have someone verifying this information.
Krohn: The intention with the licensing is to create opportunities for small business, micro businesses, to be able to go into this. And yet it also sounds like, with this high-risk, high-reward, you better be well resourced. What advice would somebody who’s interested in getting into this cannabis business, what should they know?
Fornwald: It’s hard to start a business in any industry, but this industry has additional hurdles and barriers to entry, particularly with second-round capital. Folks looking to enter the market should make sure that they have sufficient capital, or at least an avenue to obtain capital, in place before plunging your savings into something that you can’t actualize.
Moss: You have this really significant tension of encouraging these people to come into the industry, but it’s very difficult and costly to succeed. You need a team of professionals like a lawyer and an accountant on your team. A lawyer can stop you from making very costly mistakes. No one likes paying a lawyer. I understand it, but we are your partners in trying to make you as successful as possible, and we do that be keeping you compliant and within the law.
Rohloff: If you are renting a building or renting a space, make sure the landlord knows 100 percent what your intention is, as well as making sure that their loan is not SBA-backed because it is a federal loan, it is federally illegal, and the minute that landlord finds out and their mortgage is calling and saying you’re in default, you’re going to be ousted, they’re going to kick you out. Anything that is federally backed, that you’re going to be touching, you’re likely going to have blowback on because it is federally illegal. If QuickBooks realizes that you are a cannabis business, using their invoicing on their ACH platform online, they will shut your account down.
L’Esperance: If you’re entering this space, you need to do your research. You cannot skip the business plan and financial model piece of planning. You need to know your budget, so you know what you’re getting into. A lot of people try to skip this step and it shows. You should properly vet investors, partners, etc. Get your agreements in place. Work with cannabis specialized accountants & lawyers so ensure you’re compliant and protected.
Krohn: What are the promising things that you’re seeing that make you hopeful for the Minnesota cannabis marketplace?
L’Esperance: We have a lot of work to do, but we hope to see a fair, equitable and prosperous market in MN, the negative impacts on the war on drugs corrected and to see the State giving back to the communities that have been negatively and directly impacted by the war on drugs. We also hope to see the promise to cultivate and support the MN craft cannabis businesses through clearly communicated and fair rules and regulations, healthy relationships between the OCM and operators and resources to help navigate the complex space.
Moss: What I see is a really Minnesota-centric industry. If you look at the data when it comes to who is applying, it is a lot of the out-of-state bigger businesses that are going for the capped license. Those are the most valuable licenses, where you can have five stores. But I think we have almost 2,000 total applications for microbusiness licenses that allow one store and a small cultivation. These are the mom-and-pop shops, the small craft businesses that will make Minnesota’s cannabis industry unique.
Rohloff: There’s a lot of ancillary businesses that can start also that are not plant-touching: transportation, the lab, how many ancillary things that also will generate new businesses starting. So it’s not just the retail, the growers, the cultivators, you have all these other ancillary businesses that will be able to grow and thrive and also support the industry. I’m super excited for just seeing how we can continue to invest back in Minnesota. I’m excited to see how all these other businesses will thrive that will be ancillary, especially to the entertainment side of it such as cannabis clubs pop up, making it less of a stigma.
Fornwald: From a purely economic standpoint, with a (potentially) $1.5 billion industry that has all of these different layers – creating employment, sales tax revenue, and bringing lots of new funds into the state coffers – that is beneficial for all Minnesotans.
Krohn: Is there anything else you’d like to contribute that we haven’t covered in this conversation?
Fornwald: There are changes coming from a tax standpoint that could be significant. From the potential federal rescheduling of marijuana, to ongoing litigation looking at the applicability (or lack thereof) of IRS Section 280E to cannabis businesses, to avenues for legitimate businesses to amend their taxes in order to claim more deductible expense, there’s a lot of momentum right now from a tax standpoint. If these changes gain traction, they could make operating in this industry a heck of a lot more financially feasible.
L’Esperance: IRS Section 280E limits the deductions cannabis businesses are allowed to deduct to cost of goods sold. No deduction or credit is allowed in a business that operates in the trafficking of a controlled substance. Working with a specialized cannabis accountant and tax preparer who understands the complex rules of IRS Code Section 280E and Section 471(c) will help you ensure you’re not a paying penny more in tax than you’re required to and to ensure you’re remaining compliant.
Rohloff: It creates a crippling effect because a lot of businesses could be running a loss their first year, which is very typical since you’re very capital intensive, you need assets, you need to buy inventory and supplies. But with 280E you end up paying tax on gross profit, not net income when other businesses can pay tax off of net income. I was way more hopeful last summer when they were talking about descheduling it. It makes me question with as much as the current government is going after spending and where tax money is being saved. Cannabis tax brings in a lot of revenue to the IRS. We tell people, if 280E goes away, you get a very substantial bonus overnight.
